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UltraShorts and the Fall of the Uptick Rule

Eleven of the letters (including letters from the
NYSE, UBS Securities, the Managed Funds Association, the Security Traders Association, E*Trade, Trillium Trading and the Securities Industry and Financial Markets Association) applauded the SEC for proposing the elimination, and many added that they commended the fact that the SEC had conducted such a "comprehensive," "careful" and "thoughtful" pilot program (amazing how the industry all seemed to use the same plaudits...).

Curiously, the American Stock Exchange had a mixed opinion. The Amex was cautious and felt it was "premature to remove price tests from smaller securities at this time pending further analysis." So they had 15 against (mostly individuals), 11 for (mostly industry) and one neutral (industry) respond. So much for the little guy being heard ... but I digress once more.

OK, so let's return to the beginning. We know that ProShares initially launched products that could be easily hedged via a liquid futures market. They began to launch products on narrower sectors that could not be easily hedged via futures in January 2007 -- one month after the SEC proposed to abandon the uptick rule. It seems as though these levered short-sided ETFs flourished because of the change to Regulation SHO (and remember that ProShares is merely one of several purveyors of these products).

There is a very good chance that one of the biggest consequences of the removal of the uptick rule has been the proliferation of these vehicles, which give leverage and shorting power outside the margin rules. Their impact has been astounding in some cases, creating indiscriminate selling pressure and volatility in some sectors. Remember, just last Friday (Feb. 20), if you summed up the dollar volume in the 1x, 2x, and 3x short-sided ETFs based on financials and subtracted the dollar volume in the 1x, 2x, and 3x long ETFs based on financials, you'd still have close to $18 billion dollars of selling pressure brought to bear against the financials, representing a good chunk of the daily trading volume of the individual index constituents.